Discussed by Oliver Rui Chinese University of Hong Kong

1. Does Legal Protection of Minority Shareholders Affect the Variation of Ownership Concentration in China? Nianhang Xu and Shinong Wu Discussed by Oliver Rui Chinese University of Hong Kong Corporate Governance Research Incubator 2005 Shanghai

2. What does this paper study? • This paper examines the effect of legal protection of minority investors on the ownership concentration of listed companies in China for the period from 1990 to 2003. • The legal protection of minority investors is measured by legal score and ownership legal score based on laws and regulations. Corporate Governance Research Incubator 2005 Shanghai

3. What are the main findings? • Both legal enforcement and legal rules do not affect initial ownership concentration and the variation of ownership concentration after listing. • In the well-developed stage of legal protection of minority investors, the relation between legal rules and the initial ownership concentration is significantly negative. Corporate Governance Research Incubator 2005 Shanghai

4. Law and Finance Approach • The “law and finance” theory stresses the importance of legal protection of investors for the development of capital markets, and argues that legal protection is ultimately a by-product of the country’s legal origin. • The intuition is that investors are not willing to provide equity to finance a firm unless they are confident of receiving a fair return from their investment. If shareholder protection is low, minority shareholders require a high return from their investment to compensate them for the high risk of expropriation by the management/controlling shareholder. Corporate Governance Research Incubator 2005 Shanghai

5. Law and Finance Approach • The “law and finance” approach predicts that companies in countries with lower investor protection and civil law are characterized by greater ownership concentration and more pyramidal groups than companies in countries with common law and higher investor protection. • La Porta et al. (1998) find that the quality of legal protection of shareholders helps determine ownership concentration: in countries with relatively poor legal protection of investors, publicly listed companies are likely to have large block-holders. Corporate Governance Research Incubator 2005 Shanghai

6. Law and Finance Approach • Coffee (2001b) ponders whether La Porta et al’s empirical findings of a link between legal and protection of investors and ownership structure may actually reflect the reverse causal relationship: that strong markets came first and created a demand for stronger laws to protect the constituency of investors who had entered those markets. Corporate Governance Research Incubator 2005 Shanghai

7. Law and Finance Approach • The classification of countries based on the legal rules for protecting minority shareholders may be endogenous. In particular, countries with economically and politically powerful controlling shareholders may enact laws that entrench such shareholders and reduce minority rights. Corporate Governance Research Incubator 2005 Shanghai

8. Law and Finance Approach • The results might be a spurious consequence of an association between minority shareholder protection and the more general structure of financial system. Thus, firms in bank-centered financial systems might rely on debt finance, making it unnecessary for controlling shareholders to sell their equity to raise funds, but also making legal rules protecting minority shareholders less essential. In contrast, firms in market-centered financial systems rely on equity finance, forcing founders to give up control to raise capital, as well as making the protection of minority shareholders necessary. Corporate Governance Research Incubator 2005 Shanghai

9. Time-series approach • Ownership of corporation in the UK is dispersed among large number of individual and institutional investors. Consistent with the law and finance view, dispersed ownership in the UK today is associated with a high level of investor protection. • Recent work by Franks, Mayer and Rossi (2004) has provided some insights into how this occurred in the UK. They record that dispersed ownership emerged in 20th century Britain when insider and family share ownership was rapidly diluted by share issuance to fund growth through acquisitions. Regulation on its own is unlikely to be an adequate explanation for dispersed ownership in the UK. Corporate Governance Research Incubator 2005 Shanghai

10. Time-series approach • Ownership of corporation in Germany is today highly concentrated in the hands of families and other companies. By international standards investor protection is weak in Germany today. According to the law and finance theory, that is consistent with current high levels of concentration of ownership. • Franks, Mayer and Wagner (2005) provides the long-run study of ownership and control of German corporations by assembling data on the ownership and financing of firms from samples spanning almost a century from 1860 to 1950. Corporate Governance Research Incubator 2005 Shanghai

11. Time-series approach • At first sight, German financial markets look very similar to their UK counterparts. There were a large number of firms listed on German stock markets and firms raised large amounts of equity finance. This runs counter to the conventional view of Germany as a bank oriented financial system. Firms raised little finance from banks and surprisingly large amounts from stock markets. Corporate Governance Research Incubator 2005 Shanghai

12. Institutional setting in China • In China, ownership concentration is a choice by the government, not a voluntary choice by private owners. • Most of listed firms in China are those that have been carved out from existing state-owned enterprises. To maintain the state’s control on the listed firms, Chinese Company Law regulates that shares subscribed by parent SOEs cannot be less than 35% of their outstanding shares when the companies went public. To prevent the sales off of state-owned assets, all state shareholdings are non-tradable. Corporate Governance Research Incubator 2005 Shanghai

13. Methodology • The paper finds that the relation between legal rules and the initial ownership concentration is significantly negative between 1999 and 2003. Since the legal scores is constant each year and there are only 4-year data, I am not sure how to interpret the coefficient and how reliable the finding is. Corporate Governance Research Incubator 2005 Shanghai

14. Methodology • The dependent variables (H5, CR5 and CR1) are bounded between 0 and 1. I suggest use fractional response variable technique described by Papke and Wooldridge (1996). The quasi-likelihood estimation suggested by Papke and Wooldridge has the advantage over the more common logistic transformation. • Papke, L.E. and J.M. Wooldridge (1996), Econometric methods for fractional response variables with an application to 401(K) plan participation rates, Journal of Applied Econometrics, 11, 619-632. Corporate Governance Research Incubator 2005 Shanghai

15. Methodology • Table 6 examines how the nature of the controlling shareholders affects the relation between legal protection of minority investors and ownership concentration after listing. I think the interactive terms between types of controlling shareholders and ownership concentration should be included in the analysis. Corporate Governance Research Incubator 2005 Shanghai

16. Methodology • I think the sub-sample of non-state-controlled companies studied in table 7 deserves further research because the ownership concentration of private firms is less subject to the government’s restrictions. Corporate Governance Research Incubator 2005 Shanghai

17. Political Economy Approach • The “political economy” view posits that financial development is the outcome of political decisions. If compared with the law and finance approach, this theory is very dynamic in nature, since changes of the political power of different constituencies can alter the disposition of a country towards financial development. As with any political decision, financial development is the outcome of ideology and the economic interests of voters and pressure groups. Rajan and Zingales (2002) argue that the stock market can be fostered or hampered by government action depend upon the balance of powers between pressure groups. Corporate Governance Research Incubator 2005 Shanghai

18. Political Economy Approach • The “political economy” view predicts that ownership should be more concentrated and companies should be organized into groups in countries where the government has a big role in the economy. The intuition is in Pagano and Volpin (2001). When the state has a great involvement in the economy, firms need political support to grow. Hence, to maximize their political clout, businessmen need to maximize the value of assets under their control. With concentrated ownership and pyramidal groups, both goals are attained. Corporate Governance Research Incubator 2005 Shanghai